Medtronic, Inc. & Consolidated Subsidiaries v. Commissioner of Internal Revenue

Case Overview

In Medtronic, Inc. & Consolidated Subsidiaries v. Commissioner (Medtronic II), 900 F.3d 610 (8th Cir. 2018), the U.S. Court of Appeals for the Eighth Circuit vacated and remanded the Tax Court’s Section 482 royalty determination for tax years 2005–2006.

The Eighth Circuit did not decide what the correct arm’s length royalty should be. Instead, it held that the Tax Court’s factual findings were too underdeveloped to permit appellate review of the Tax Court’s use of a CUT anchored on a third-party settlement license (the “Pacesetter” agreement).

Key Facts

• Medtronic’s U.S. parent (“Medtronic US”) licensed intangibles used to manufacture Class III medical devices and “leads” to its Puerto Rico manufacturing affiliate (“Medtronic Puerto Rico” / MPROC).
• In an earlier (2002) audit resolution, Medtronic and the IRS entered a Memorandum of Understanding with royalty rates of 44% (devices) and 26% (leads), expressly treated by both sides as a compromise rather than an arm’s length result.
• For 2005–2006, the IRS concluded Medtronic’s Puerto Rico royalties were too low and applied the Comparable Profits Method (CPM).
• The IRS issued a notice of deficiency and later amended it to assert deficiencies (devices/leads) of $548,180,115 (2005) and $810,301,695 (2006).
• After trial, the Tax Court rejected both parties’ valuations, conducted its own analysis, and set royalty rates of 44% (devices) and 22% (leads), resulting in a $26,711,582 deficiency (2005) and a $12,459,734 overpayment (2006) (order dated Jan. 25, 2017).
• The Commissioner appealed (focused on the devices and leads licenses).

What the Tax Court Used as a CUT

The Tax Court treated a 1992 settlement agreement between Medtronic US and Pacesetter’s parent company as the “best” CUT. The agreement:

• arose from patent litigation settlement;
• included cross-licenses;
• provided a $75 million lump-sum payment; and
• provided Medtronic a 7% running royalty for future U.S. sales of covered cardiac stimulation devices/components.

The Eighth Circuit noted that the Tax Court made certain percentage adjustments (including for “know-how” and product-scope differences), but found the Tax Court did not make sufficient findings to show that the Pacesetter agreement was reliably comparable to Medtronic’s controlled licenses.

Issues on Appeal (Why the Eighth Circuit Could Not Review)

Under the “best method” rule and CUT regulations (Treas. Reg. §§ 1.482-1(c), 1.482-1(d), and 1.482-4(c)), the Eighth Circuit held the Tax Court did not do enough work on key comparability drivers:

1. Litigation/“ordinary course of business”

   • The Tax Court did not adequately address whether a litigation-driven settlement was comparable to a routine intercompany license, including whether it was made in the “ordinary course of business” (a factor affecting reliability).

2. Contract terms: lump sum + cross-license

   • The Tax Court acknowledged the settlement included a lump-sum payment and cross-licenses, but did not explain how those terms affected comparability to MPROC’s royalty-only controlled licenses.

3. Scope of intangibles (patents vs. broader bundle)

   • The Pacesetter agreement was limited to patents and expressly excluded a wide range of non-patent intangibles (technical know-how, designs, drawings, software source code, etc.), while Medtronic’s controlled license did not.
   • The Eighth Circuit concluded more findings were needed to evaluate whether the Tax Court’s adjustments adequately bridged this gap.

4. Risk and product liability allocation

   • The Tax Court discounted the IRS position (including an argument that MPROC bore only about 11% of relevant manufacturing costs, including product liability expense) and allocated almost 50% of device profits to MPROC—without making a specific finding as to what risk and product liability expense was properly attributable to MPROC.
   • Because that risk allocation underpinned the court’s royalty economics, the lack of findings prevented meaningful review.

A concurrence emphasized that the regulations “require analysis” of comparability factors, not just conclusions.

Holding and Disposition

The Eighth Circuit vacated the Tax Court’s January 25, 2017 order and remanded for further proceedings and fuller factual findings consistent with the appellate opinion.

Practical Takeaways for Practitioners

• Treat CUT comparability as a factor-by-factor exercise (contract terms, collateral transactions, scope of rights/intangibles, profit potential, etc.), and make the write-up reviewable on its face.
• Settlement licenses can be tempting “comparables,” but the litigation context, payment form, and cross-licenses must be analyzed and (if used) adjusted transparently.
• If the uncontrolled agreement covers only patents, but the controlled license covers a broader intangible bundle, explicitly quantify and support adjustments—or explain why a CUT is no longer reliable.
• When arguing that a manufacturer earns more due to quality and product-liability risk, support the claim with evidence that ties specific costs/risks to the tested party (and to the pricing conclusion).

Related Content

For practical guidance on building defensible intangible-license files, see Documentation for Intangibles and Benchmarking Study Guide. For core concepts applied in Medtronic II, review Comparable Uncontrolled Price and Arm's Length Range.

Frequently Asked Questions

Q1. What does “CUT” mean in U.S. transfer pricing for intangibles?
A CUT (Comparable Uncontrolled Transaction) prices a controlled intangible transfer by reference to a sufficiently comparable uncontrolled transaction, with reliable adjustments where needed (Treas. Reg. §1.482-4(c)).

Q2. Did the Eighth Circuit reject the CUT method in Medtronic?
No. The court rejected the Tax Court’s analysis as inadequately supported by findings; it remanded for fuller factual development.

Q3. What were the biggest comparability problems with the Pacesetter agreement?
That it was a litigation settlement, included a lump-sum payment and cross-licenses, differed in the intangibles covered (patents vs. broader intangibles), and lacked findings on risk/product-liability allocation.

Q4. Did the court require CPM instead?
No. The court did not choose a method. It held the record and findings were insufficient to evaluate whether the Tax Court properly applied a CUT (or whether another method would be more reliable).

Q5. What happened after remand?
The case returned to the Tax Court for a new analysis consistent with the Eighth Circuit’s critique, and later proceedings continued (see related Medtronic remand decisions).